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					                   Economics and Conservation in the Tropics:
                   A Strategic Dialogue
                   January 31 – February 1, 2008
CONFERENCE PAPER

                   Necessary Conditions
                   for Ecosystem Service
                   Payments

                   Sven Wunder
Economics and Conservation in the Tropics                                                                Wunder



            Necessary Conditions for Ecosystem Service Payments
                                             Sven Wunder∗



What Are We Talking About?
        A now widely accepted definition of payments for environmental services (PES) contains
these elements (Wunder 2007):

        •   A voluntary transaction

        •   A well-defined environmental service or a land use likely to secure its provision

        •   At least one buyer

        •   At least one provider effectively controlling service provision

        •   If and only if the environmental service provider secures service provision
            (conditionality)

        One should refer to “environmental” rather than “ecosystem” services. For instance, the
carbon-sequestration service of an exotic tree plantation is specific, not “systemic”; the synergies
between different services provided are often exaggerated. PES can be used for preserving,
restoring, and creating new environmental services (jointly referred to as “conservation” below).
PES currently exist for four environmental service types: carbon, watersheds, biodiversity, and
landscape beauty.

        The five PES principles hold for several real-world schemes, but the number of existing
“PES-like” schemes—satisfying most but not all criteria—is much larger. Some PES schemes
are “self-organized,” normally at the initiative of environmental service buyers or intermediaries
like non-governmental organizations (NGOs). Examples from developing countries are
community and smallholder carbon schemes worldwide or mushrooming watershed schemes in
Latin America (table 1). In developed countries, examples of self-organized PES schemes
include the much-cited Catskills watershed protection scheme in New York or Vittel’s watershed
scheme in France. Typically, self-organized schemes are small-to-medium-scale sized. Single-


∗Sven Wunder, Center for Internation Forestry Research, (CIFOR), Trav. Dr. Enéas Pinheiro S/N, 66.095-
100 Belem, Brazil; (email) s.wunder@cgiar.org



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    Economics and Conservation in the Tropics                                                              Wunder



    site schemes may range from 496 hectares (Pimampiro watershed PES, Ecuador) and 5,100
    hectares (Vittel watershed PES, France); and multi-site schemes from 3,500 hectares (RISEMP,
    Regional Integrated Silvopastoral Ecosystem Management Project in Costa Rica, Colombia, and
    Nicaragua) to 22,300 hectares (PROFAFOR carbon sequestration program, Ecuador).

                       Table 1     Examples of PES Type of Experiences Worldwide


   Scheme      Country       Service        Land uses       Seller      Scale        Spatial     Years       Source
                                             paid for                                extent

RISEMP        Colombia Biodiversity,      Restoration      NGOs,      Internation     3500       2002–   Pagiola et al.
              Costa     carbon            (silvopasture)   IO, states al (3          hectares            2004, 27; 2007
              Rica                                                    countries)
              Nicaragua

Pimampiro     Ecuador     Watershed       Conservation/    Municipal Local             496       2000–   Echavarría et
                                          minor restora-   govern-                   hectares            al. 2004;
                                          tion             ment                                          Wunder and
                                                                                                         Albán 2008

Conservation USA          Watersheds,     Restoration      Central    National      14,500,000   1985–   Claassen et al.
Reserve                   biodiversity,   (agricultural    state                     hectares            2008
Program                                   practices and
(CRP)                     soil+           land retirement)

PROFAFOR      Ecuador     Carbon          Restoration      Private Regional           22,300     1993–   Albán and
                                          (plantation)     company (selected         hectares            Argüello 2004;
                                                                   provinces)                            Wunder and
                                                                                                         Albán 2008

PSA program Costa         Carbon,         Conservation/    Public     National       270,000     1996    Pagiola 2008
            Rica          watersheds,     minor restor-    sector+                   hectares
                          biodiversity,   ation
                          landscape

Vittel        France      Watershed       Conservation/    Private Local              5100       1993–   Perrot-Maître
                                          restoration      company                   hectares            2006, 24.
                                          (agricultural
                                          practices)

Source: Adapted from Wunder et al. 2008




           Other PES-like schemes are run by national states, acting as buyers on behalf of
    environmental service users. They are typically much larger in area and tend to combine several
    services, but also feature various side objectives (poverty alleviation, regional and sectoral
    development). This bolsters political support, but may endanger their effectiveness in reaching
    environmental goals. Examples include agro-environmental schemes in developed economies,


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Economics and Conservation in the Tropics                                                  Wunder



such as the U.S. Conservation Reserve Program (about 14.5 million hectares) or the European
Union’s various agro-biodiversity programs, but also those in developing and emerging
economies, e.g., China’s SLCP (Sloping Land Conversion Program)—7.2 million hectares of
land retired and 4.9 million hectares planted with trees;, Costa Rica’s PSA (pioneering
environmental services payments program)—270,000 hectares; or Mexico’s PSAH (National
Program for Hydrological Environmental Services)—126,000 hectares.

Economic Preconditions
        The key economic rationale for PES is that an “externality” exists, i.e., compensating an
outside service benefit that the landowner (potentially or de facto) provides to external
beneficiaries. PES thus recognizes hard tradeoffs in conservation: the landowner and the
external beneficiaries (downstream water users, global carbon buyers, etc.) have diverging
interests, and unless the latter compensate the former, the service will be lost.

        Secondly, the value of the service(s) at hand (determining the environmental service
user’s willingness-to-pay [WTP] for PES) must exceed the environmental service provider’s
opportunity costs, i.e., the profit foregone from abandoning the first-best land-use plan
(determining the environmental service provider’s willingness-to-accept [WTA] PES, plus
transaction costs [TC]). In some situations, profits from alternative land uses may be too high for
conservation to compete or transaction costs are prohibitive for PES (i.e., minimum WTA + TC
> maximum WTP).

Competitive Preconditions
         A frequent misunderstanding is that PES require “markets” to function. Only for carbon
services, a homogeneous environmental service being universally provided, have some markets
(e.g., the Chicago Climate Exchange) evolved. All other three environmental services
(biodiversity, watersheds, and landscape beauty) are usually too spatially specific to allow for
true competition: the users have to work with the providers which happen to occupy the land
that provides “their” targeted environmental services. Most existing self-organized PES are thus
monopsonies (transactions with one single buyer, e.g., the state or a hydro-electrical power plant)
or oligopsonies (only few large buyers who can dominate the negotiations). Under genuine
market preconditions with atomistic supply and demand conditions, most PES schemes would, in
fact, never happen because the transaction costs of negotiating PES deals would be too high. So-
called “market-based tools” (e.g., tradable development rights, biodiversity offsets) can
sometimes help achieve the environmental goal. However, markets and competition are neither
                                                    3
Economics and Conservation in the Tropics                                                  Wunder



necessary nor sufficient preconditions for PES. Thus, PES design needs to draw much more on
contract theory than on marketing literature.

Cultural Preconditions
        Economic incentives constitute the core of PES. If environmental service providers feel
little motivated by receiving payments or consider them socially inappropriate, then PES will not
work. When non-economic value systems are important and functioning, there may be strong
resistance to the introduction of PES. Nowhere is this as apparent as with water access, often
considered a human right that is threatened by PES monetization. The so-called “Andean Water
Vision,” built on indigenous systems of upstream-downstream reciprocity, has in particular
proved to be at odds with watershed PES and is locally considered a neoliberal Trojan horse.
According to psychological experiments, introducing (small) monetary payments on top of
(strong) pre-existing intrinsic values (e.g., paying people to protect their own revered forest)
could at worst undermine rather than strengthen conservation.

       In most cultural contexts, PES are currently being accepted. Where traditional systems
become dysfunctional (e.g., due to increased resource pressures), PES can also gain
acceptability. Using non-monetary PES payments can in some cultural circumstances be
preferable. The PES mechanism may thus be designed adaptively, to complement pre-existing
values and natural resource management systems.

Institutional Preconditions
        Although natural resource externalities are widespread globally, in a few places, PES
have been developed locally in a bottom-up way. PES require trust between service users and
providers—expecting mutual contract compliance and excluding misleading motives (e.g., users
taking over providers’ lands). Since users and providers have inherently conflicting interests,
trust seldom develops naturally between them; an honest intermediate broker is required. In fact,
the idea of applying PES in most cases comes from external intermediaries. Yet, in situations of
great conflict and when rights to the land providing the service are not (and cannot be rendered)
exclusive, PES cannot be applied. Given the frequency of these situations in the southern
hemisphere, institutional PES constraints are often binding.

        On the other hand, PES is frequently also a fitting response to institutional shortcomings,
in particular, difficulties to apply command-and-control policies in developing countries. In
developed countries, e.g., much watershed protection has occurred through effective legal land

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Economics and Conservation in the Tropics                                                   Wunder



protection. In other words, where command-and-control tools are working well, PES may be
needed less as an incentive for voluntary change. However, PES may still be used here as a
compensation for obligatory changes ensuring fairness and equity, or conditionality may be
brought in through cross-compliance (productive subsidies depending on compliance with
environmental command and control), as is the case for many agro-environmental schemes in the
northern hemisphere.

         In developing countries, command-and-control efficiency is often restricted by weak
institutions and poor governance, especially at the agricultural frontier. There is also a moral
imperative not to hurt poor farmers through strict prohibitions, who traditionally occupy
productively marginal yet environmentally fragile lands. Land is often considered abundant, and
its occupation and transformation is commonly accepted as a livelihood strategy for the poor,
making command-and-control enforcement politically unfeasible. PES can thus be an effective
and more equitable conservation response to those institutional limitations.

        Can PES schemes be effectively enforced? In principle, contracts could be tied to the
existing judicial system, so that non-complying providers can be legally pursued. Conservation
easements are one such PES tool (satisfying the five criteria above) which makes use of this
possibility. However, its effectiveness depends on whether the judicial system is willing and able
to assume the transaction costs of effectively enforcing the PES contract. In developing
countries, easements can thus run into some of the same implementation obstacles as command-
and-control systems. For the same reason, easements have been applied much more frequently in
developed than in developing countries. In the latter, it is often preferable to have contracts that
are independent or at least not fully dependent on the judicial system. The main point of leverage
here is to have a system of recurrent contingent payments (in principle, to infinity), which are
stopped, reduced, or suspended in case of non-compliance (depending on the severity of the
breech). This system can be quite efficient, but might run into trouble when upfront conservation
costs are high (e.g., with tree planting): more or less equal recurrent payments will then not be
sufficiently attractive for the environmental service seller, while high upfront payments make the
buyer lose leverage.

Informational Preconditions
        PES are relatively information-intensive, which triggers transactions costs. However, TCs
tend to be comparatively higher in the start-up period prior to the first payment (costly
negotiation, environmental-service baseline assessment, system design, etc.) than in the
operational phase (monitoring, enforcement/sanctioning, administration) when the direct
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Economics and Conservation in the Tropics                                                   Wunder



implementation method of PES usually enhances cost effectiveness. For instance, in the two
Ecuadorian cases of Pimampiro (watershed) and PROFAFOR (carbon sequestration), start-up
costs were US$ 76/hectare and $184/hectare, respectively, while recurrent transaction costs in
the operational phase were $7 and $3, respectively (Wunder and Albán 2007).

        Transactional costs could be a real bottleneck for PES-led conservation, especially when
there are multiple environmental service buyers and sellers which are socially diversified, and
when the targeted service is biophysically complex. For instance, measuring hydrological
linkages to scientific standards may come at costs grossly exceeding the required payments
proper, which in most cases will constitute a deal breaker. Small-scale schemes particularly
suffer the drawbacks of high start-up costs.

PES Implementation Features
        At first sight, the obstacles to PES implementation might seem formidable, but in many
cases, PES just make transparent the contradictions that implicitly apply to other conservation
tools. For instance, if potential service providers decline to switch to environmentally benign
productive activities because their opportunity costs are not covered (economic obstacle), this
will clearly be featured during the PES negotiations. In many other conservation actions, this
may remain an underlying root cause of failure that is not openly recognized. Land-access
exclusion rights (institutional obstacle) are sine qua non for PES, but indirectly so are they for
other actions. For instance, an integrated conservation and development project might be very
effective at engaging a community to shift the livelihoods of its members into a more
conservation-friendly direction. But, if lower local occupancy of the land targeted for
conservation induces outsiders to take control over it, the line of action of the integrated
conservation and development project will fail due to the same root constraint. Finally, baselines
of service provision are key for PES and might be difficult and expensive to set (informational
obstacle). However, as has been correctly pointed out, in fact, any conservation action should
carefully define and monitor “what would happen in the absence of the targeted intervention”
(Ferraro and Pattanayak 2006).

         In which fields and scenarios are PES thus likely to face implementation obstacles that
are genuinely superior to those of other conservation tools? As mentioned, probably some start-
up costs are higher and some obstacles more evident, simply because PES requires a greater
degree of explicitness. These cases most of all reconfirm that conservation per se is an
undertaking riddled with obstacles. However, one field where PES truly “underperforms” other
tools is the high cost of negotiating contracts, at least in self-organized schemes where both the
                                                     6
Economics and Conservation in the Tropics                                                  Wunder



buyer and the seller are fully voluntary. Where many buyers and sellers (perhaps of various
services from the same land plot) are present, PES schemes are unlikely to emerge, unless the
negotiation parties are extremely well-organized from the outset. However, the proper process of
PES negotiation could, in turn, also provide side benefits in terms of platforms for
democratization and improved governance—which is one reason why donors tend to be
interested in PES. Hence, some transaction costs are not worse, but are also actually good for
something.

The Beauty of PES
       In spite of the current incipient scale and spread of self-organized PES schemes and the
implementation imperfections of many larger-scale state-led PES-like schemes, many
conservation (and rural development) stakeholders continue to have high hopes for PES, as key
to a new paradigm of “contractual conservation.” Why is PES thought to be such a promising
idea? One can divide PES proponents into two stylized camps:

       •   Supply-side innovation: PES, as a direct, conditional way of “buying conservation,”
           promises to use existing conservation funds more efficiently, with a strong focus on
           conditionality, i.e. the environmental service provider securing environmental service
           provision, and less so on increased user financing (Ferraro and Kiss 2002).

       •   Integrating supply and demand sides: PES is a tool to buy conservation and
           generate sustainable funding, where the “user pays” and “provider gets” elements of
           PES jointly assure a socially efficient resource allocation (Pagiola and Platais 2007).

        Both of these camps can provide relevant perspectives: supply-side innovation more so
for global non-exclusive environmental services (biodiversity and carbon) where direct user
payments have little prospects of raising funding; and integrated supply and demand sides more
so for watershed services or landscape values where local user financing is a sine qua non.

Making PES Flourish
        As shown above, PES is an attractive conservation tool, both as a supply-side innovation
and as an integrated financing tool. The economic preconditions for PES (win-lose/lose-win
scenarios with favorable WTP/WTA ratios) are widespread, and cultural obstacles can most
frequently be overcome. If we were to scale up PES from their current early development stage,
the institutional and informational bottlenecks would be more severe: insecure land rights, lack


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Economics and Conservation in the Tropics                                                   Wunder



of trusts, free-riding service users, and high transaction costs. What can be done to ease these
constraints?

        In self-organized schemes, e.g., single watershed deals in developing countries, donors
can help by subsidizing high start-up costs under the rationale that these PES appear to be cost-
effective and sustainable once up and running. Rapid biophysical assessment methods (e.g., for
watershed protection and carbon sequestration) can reduce the high costs of setting baselines. In
the social-science sphere, directly replicating models of negotiation and design (e.g., for
communities and smallholders) can also reduce costs and enhance trust building. In some cases,
land-tenure consolidation can help, while in others it is too costly or difficult, thus making PES
non-viable. Self-organized schemes are important for local environmental management (e.g.,
watersheds or ecotourism) and as pilots for our continuous PES learning and adaptation.

         However, many global environmental problems (e.g., reaping biodiversity and carbon
benefits by avoiding deforestation) are probably best addressed through scaled-up, state-run
schemes. In principle, a far-sighted and credible state can address both institutional and
informational transactional-cost constraints by providing an umbrella for multiple-user payments
(thus minimizing free riding), being a trustworthy honest broker, addressing spatially fungible
environmental threats at a sufficiently large scale (i.e., counteracting so-called “leakage”),
providing more and cheaper land-use monitoring, etc. The real-world problem is that many
developing-country nation states are seen as neither environmentally far-sighted nor
institutionally credible. Furthermore, PES-like state-run schemes face constant dangers of being
hijacked by competing political agendas and, at worst, degenerating into undifferentiated rural
subsidies with little environmental returns. The conservation challenge here is to increase and
maintain the environmental focus of PES through rate differentiation and spatial targeting to
high-threat and high-service yielding areas.




                                                     8
Economics and Conservation in the Tropics                                               Wunder




References
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       proyectos de fijación de carbono en el Ecuador. El caso de PROFAFOR – FACE,”
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Echavarría, M., J. Vogel, M. Albán, and F. Meneses. 2004. “The Impacts of Payments for
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                                                   9
Economics and Conservation in the Tropics                                              Wunder



Wunder, S., and Albán, M. 2008. “Decentralized Payments for Environmental Services: The
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